The rise in the Dow Jones Industrial Average is limited by a significant resistance feature, which is derived from the dominating chart patterns on the index.
The breakout above 11,600 from the L shaped consolidation pattern in October created a symmetrical triangle. The base of the pattern is approximately 745 index points. The breakout from this pattern is often very dramatic as the indecision is broken with the announcement of news. The downside target for this pattern was at 11,150. This target was not quite achieved with the fall stopping at 11,223.
This was followed by an equally rapid rally that carried the index above the value of the apex of the symmetrical triangle. This is a new feature of this pattern behavior. A rapid breakout and achievement of the pattern target levels and then followed by an equally rapid retracement.
This snapback behavior took the market back to 12,000. The momentum disappeared from the rally and there is a weak continuation of the up move. This rise is limited by another long-term feature on the Dow chart.
To understand this feature we need a bit of a history refresher. The Dow developed a head and shoulder pattern between April 2011 and July 2011. This is a trend reversal pattern. The downside targets at 10,600 were achieved and were followed by the L-shaped consolidation. The neckline trend line of the head and shoulder pattern is projected forward and this is now providing a strong resistance level.
The initial upside target for the first breakout from the L shaped consolation pattern was located near 12,300. This was calculated by using the value of the head and shoulder neckline projected to the right of the chart pattern. The lingering influence of the head and shoulder pattern neckline proved more powerful and the market retreated away from 12,300.
This line continues to act as a resistance level and this places a limit on the current rally. That is currently around 12,500 and has a value near 12,600 by the end of January. The rally is losing momentum so it is tracking the resistance feature. The continuing upside target for the rally is defined by the value of the head and shoulder neckline trend line.
There is a high probability that a retreat from this resistance trend line will be rapid. Traders will be ready to close out profitable positions as the Dow moves towards the value of the resistance line and open short positions. The initial support for a retreat is located near 11,900 to 12,000.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
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